Thank You

Error.

Against all odds, bank loans have become cool. Once the arcane province of corporate bean counters, bank credit officers, and institutional investors, bank loans are now attracting strong attention from yield-starved individuals. These folks have been pouring gobs of money into mutual funds that invest in bank loans; the funds saw net inflows of $39 billion in the past 12 months, the second-biggest haul of any Morningstar fund category, after intermediate-term bonds. It's practically the stuff of cocktail-party chatter.

Joseph Welsh was plying this market long before it was fashionable, and he is now one of its stars. His
Oppenheimer Senior Floating Rate
fund (ticker: OOSAX) has returned an average of 5.4% a year over the past 10 years, putting it in the top one percent of all bank-loan funds, according to Morningstar.

The $12 billion, Denver-based fund invests in floating-rate loans to companies that typically carry heavy debt and credit ratings below investment grade. The loans are a little like junk bonds but are senior in the companies' credit structures, meaning they must be paid off before bonds if serious financial trouble hits. And the floating rates, rarities on corporate bonds, offer welcome protection in an era when bond investors everywhere are worried about rising interest rates. The rates on Welsh's loans, which are reset every 30 to 90 days, would rise with the tide, while fixed-rate bonds and loans would see their values sink.

Welsh's career path has prepared him well for this moment. In the mid-1980s, when he was working as a junior accountant, he spent his lunch breaks poring over The Wall Street Journal. The big news was about hostile takeovers and leveraged buyouts, and that whet his appetite for high-yield bonds. After earning a C.P.A. at night, the Philadelphia-bred son of a Teamster landed a job at junk-bond boutique W.R. Huff Asset Managementin the early 1990s and then moved to Oppenheimer's high-yield group in 1995. Four years later, he launched the Senior Floating Rate Fund.

Welsh, 49, professes to be unfazed by the stampede into the bank-loan market. He points out that yields on his types of loans, now around four percentage points over the London interbank offered rate, are more than double the levels of 2006, when the market was overheating as a result of the rush into credit-default swaps. While he doesn't see a bubble, he notes that many bank loans are being valued at or above par, which does limit upside: "We are clear with people that the market is about income and wealth preservation, not a get-rich-quick tool."

But he does expect still more investors to turn to floating-rate bank debt as they come to appreciate interest-rate risk. That's especially so for all the investors who flocked to "safety" by buying investment-grade debt, which typically carries fixed rates. Consider Apple's $17 billion bond offering in April, which featured various maturities. If rates were to rise by just one percentage point, Welsh figures, the 30-year bonds in the bunch would lose nearly 18% of their value.

"Investors have to get over this aura that investment-grade is 'safe' when it's really not," Welsh says.

Unlike others in the category, Welsh and his team—including co-manager Margaret Hui and eight analysts—stick with senior floating-rate debt rather than also veering into high-yield. That purist focus and a decision not to use leverage have held the fund back somewhat this year—returns are running at an annualized 3%. But the strategy paid off during the bond rout of May and June: The fund was down just 0.17%. The average high-yield bond fund, by contrast, was off 3%, and emerging-market bond funds were down 9%, according to Morningstar.

To keep a lid on credit risk, the fund holds loans from more than 300 companies, with no single issuer typically making up more than 1% of assets. The analysts, most with more than a decade of experience, pick the loans based on intense credit work. They analyze management's motives, the strength of collateral and the nuances of the deal terms to find the best securities in a sector for the least risk.

Oppenheimer Senior Floating Rate Fund

Total Returns*

1-Yr

3-Yr

5-Yr

OOSAX

7.42%

7.18%

6.49%

Barclays US Aggregate Bond

-2.18

3.30

4.88

% Of

Top 10 Issuers

Assets**

Institutional Money Market Fund

4.6%

TXU

1.4

Clear Channel Communications

1.2

First Data

1.1

Vertafore

0.9

Univision Communications

0.9

US Foodservice TL

0.9

WideOpenWest Finance

0.9

Caesars Entertainment

0.9

Affinion Group

0.8

Total:

13.6%

*All returns are as of 7/10/13; three- and five-year returns are annualized. ** as of 5/31/13. Source: Morningstar; Oppenheimer Funds

That kind of digging paid off nicely heading into the financial crisis. The analysts began to see a narrowing between the amounts investors received for lending to a good company versus a riskier one. As a result, the team began to trade up, looking for opportunities to get a comparable interest rate, or give up just a small amount, in return for less risk. Result: The fund held losses to 29%—a painful hit, but better than nearly 60% of its peers.

"The key to our process is old-fashioned, sensible lending, and that is what we always have tried to do—even when it seems ridiculous, like at the end of 2008 when loans were trading at 35 cents or 50 cents to the dollar," Welsh says. Lately, he and the team have liked the gaming sector, which is seeing revenue back to almost 2007 record levels but with stronger balance sheets and, as a result of cost-cutting, better margins. Among the holdings:
Caesars EntertainmentCZR 3.992015968063872%Caesars Entertainment Corp.U.S.: NasdaqUSD10.42
0.43.992015968063872%
/Date(1427829772417-0500)/
Volume (Delayed 15m)
:
552211
P/E Ratio
N/AMarket Cap
1449663625.79819
Dividend Yield
N/ARev. per Employee
125235More quote details and news »CZRinYour ValueYour ChangeShort position
(CZR) and
MGM Resorts Internationalmgm -0.611189468735308%MGM Resorts InternationalU.S.: NYSEUSD21.14
-0.13-0.611189468735308%
/Date(1427829816461-0500)/
Volume (Delayed 15m)
:
7496433
P/E Ratio
N/AMarket Cap
10450227485.6474
Dividend Yield
N/ARev. per Employee
162613More quote details and news »mgminYour ValueYour ChangeShort position
(MGM). Fitness centers fall within the gaming category and are seeing healthy same-store growth, and also look attractive. The fund holds 24 Hour Fitness Worldwide.

Welsh is even seeing opportunity among some of the "covenant-light" deals others have characterized as a sign the market is getting too hot. These are loans with looser rules for borrowers over such matters as incurring additional debt. Welsh says some of these deals can actually be stronger than those with traditional covenants. Take a recent loan from grocer Albertsons that the fund recently bought. Although it was covenant-light, it was secured by real estate worth more than twice the loan amount, while most bank loans to retailers don't have any hard collateral beyond inventory.

It all boils down to this: "We just study the companies and make sure they can pay us back," Welsh says.